Kilroy Realty Corporation Q1 2010 Earnings Call Transcript

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 |  About: Kilroy Realty Corporation (KRC)
by: SA Transcripts

Kilroy Realty Corporation (NYSE:KRC)

Q1 2010 Earnings Call

April 26, 2010 5:00 pm ET

Executives

Tyler H. Rose – Chief Financial Officer

John B. Kilroy, Jr. – President, Chief Executive Officer & Director

Jeffrey C. Hawken – Chief Operating Officer & Executive Vice President

Heidi Roth – Controller

Michelle Ngo – Treasurer

Analysts

Jamie Feldman – Bank of America Merrill Lynch

Chris Caton – Morgan Stanley

John Guinee – Stifel Nicolaus & Company, Inc.

Mitchell Germain – JMP Securities

Michael Knott – Green Street Advisors, Inc.

Michael Billerman – Citi

Dave Rodgers – RBC Capital Markets

Ross Nassbaum – UBS

Operator

Welcome to the first quarter 2010 Kilroy Realty Corporation earnings conference call. At this time all participants are in a listen only mode. We will facilitate a question and answer session at the end of the presentation. (Operator Instructions) I would now like to turn your presentation over to Mr. Tyler Rose, Chief Financial Officer.

Tyler H. Rose

With me today are John Kilroy, our CEO; Jeff Hawken, our COO; Heidi Roth, our Controller; and Michelle Ngo, our Treasurer. At the outset I need to say that some of the information we will be discuss this morning is forward-looking in nature. Please refer to our supplemental package for a statement regarding forward-looking information on this call and in the supplementals.

This call is being telecast live on our website and will be available for replay for the next 10 days both by phone and over the Internet. Our press release and supplemental package have been filed on a Form 8K with the SEC and both are also available on our website. John will start the call with an overview of the quarter in our key markets. I’ll add financial highlights and then update earnings guidance for 2010 and then we’ll be happy to take your questions.

John B. Kilroy, Jr.

It’s been a busy period for us at KRC so far this year. As most of you know from our public disclosures over the past few weeks, we are in the process of acquiring two new office campuses, one in San Diego and one in San Francisco. We’ve been active in the capital markets raising nearly $300 million in common equity and we’ve received investment grade rates from both Moodys and S&P. We also continue to see good momentum in our leasing activity.

Year-to-date we’ve signed new or renewing leases on about 494,000 square feet of space including a 15 year corporate headquarters lease for our entire 141,000 square foot governors park office property in San Diego County and an 11 year corporate headquarters lease for a 90,000 square foot Agoura Road office building in North Los Angeles County.

All of this active took place against the real estate market that remains chopping but is showing clear signs of stabilizing. Our occupancy remained flat from last quarter at 82.8% and cash rents went down 12%, about the same as last quarter on the leases that were signed year-to-date. Financial strength remains a crucial advantage and today’s still highly competitive leasing environment and has continued to underwrite landlords seeking owners who can deliver on promises and maintain their buildings.

This point applies to acquisitions as well where buyers like KRC do not have financing contingencies and who can provide surety of execution and have a clear competitive advantage. Now, let me give you some details on our recent acquisitions. In mid March we completed the acquisitions of an 89,000 square foot office building in Mission Valley, a submarket of San Diego County.

We purchased the building for $18 million, an all cash transaction. It’s currently 72% occupied. The building is one of four properties within Mission City Corporate Center. We are also acquiring the three remaining buildings totaling 190,000 square feet for approximately $52 million. They are 81% occupied.

The completion of this second transaction is subject to the assumption of $52 million of existing debt that is secured by the three buildings. The acquisition is expected to close in the second quarter. We were attracted to this asset because it was extremely well located with terrific amenities adjacent to the project including 560,000 square feet of retail, immediate access to the I15 freeway and adjacency to the San Diego Light Rail System.

We see a solid opportunity to significantly increase the value of this property as it has been under leased given the capital constraints of the prior owner and was acquired at an average purchase price of approximately $250 per square foot which is well below replacement costs. The cap rate is in the mid 7% range. We view the Mission Valley location as an excellent expansion of our presence in San Diego. It introduces KRC to a broader array of young growing companies many of whom who will develop larger real estate needs down the road that our portfolio of properties and land pipeline may satisfy. The total vacancy rate in the Mission Valley area is currently 19%.

With our third transaction, we’ve reentered Northern California and are in escrow to purchase 303 2nd Street which is in the South Financial District submarket of downtown San Francisco. The purchase price was $237 million. 303 2nd street is a two tower, 732,000 square foot multitenant office complex occupying a full city block surrounded by Folsom and Harrison Streets. The two towers are interconnected at the lower levels which provides tenants with the opportunity for larger floor plays.

Rubicam, Simatech, Hewlett-Packard, Parson Brinckerhoff and Wells Fargo. We expect the transaction to close in the second quarter subject to customary closing conditions. The property is an excellent reentry point for KRC in to the Bay area real estate market and will provide a strong foothold from which to build our presence there. The cap rate is in the mid 6% range on in place income and the purchase price of approximately $325 per square foot is well below replacement costs.

The Class A south financial district submarket in which the project is located encompasses approximately 19 million square feet within 45 buildings and currently has a vacancy rate of 11.8%. Financial institutions, technology companies, legal and professional services drive demand in this market and increasingly its attracted to the technology sector. The 303 project has terrific access by an adjacent freeway ramp and is a short walking distance to the BART System, Mosconi Center and the new ballpark. We’ll be a major benefactor of the multibillion dollar transbay redevelopment land which includes a transit center for BART, bus, light rail and Cal Train.

Against this backdrop of activity, our larger goals for the year have not changed: building on our leasing momentum; maintain our financial strength and flexibility; consider additional potential acquisitions that make financial and strategic sense; and work to ensure that our land pipeline is optimally entitled for the future. All of these efforts are geared towards creating meaningful long term growth.

Now, let’s review our individual markets beginning with San Diego where we continue to make progress. Overall we’ve executed 303,000 square feet of leases in San Diego since the beginning of the year including the new 15 year lease for our entire 141,000 square foot Governor Park property that I mentioned earlier. Mitchell International, the new tenant provides information and claims processing management systems to the insurance industry.

We’ve moved our core portfolio in San Diego up to 85.3% leased. Incorporating the Mission Valley property we acquired in March, our properties in San Diego are 85.1% leased up from 82.5% at the end of last quarter. The individual San Diego submarket vacancy rates and occupancy rates are as follows starting with Del Mar. Current direct vacancy is approximately 17.4%, total vacancy 21.3%. Our stabilized properties in Del Mar are 94.5% occupied and 95.3% leased.

South of Del Mar in Sorrento Mesa, KRC competes in the two and three story office market. Direct vacancy for this product type is currently 10.6%, total vacancy is 11.9% down from 12.9% and 15.4% respectively last quarter. We have stabilized properties in the submarket totaling approximately two million square feet that are currently 76.4% occupied and 79.5% leased.

Further, south in the UTC Governor Park submarket, we compete in the same two story product type with properties totaling about 431,000 square feet. Current direct vacancy is about 10.5%, total vacancy is 17.7%. Our properties here are currently 53.9% occupied and with the execution of the Mitchell International lease 86.7% leased up from 55.4% last quarter. Along the I15 corridor eats of Del Mar, KRC owns approximately 1.2 million square feet of stabilized office space. The two story product type here as a current direct vacancy rate of 12.8% and total vacancy of 13.4%

For Class A product direct vacancy of 28.8 and total vacancy is 29.9% down significantly from 36.3% and 37.4% last quarter. Our stabilized properties here are 71.1% occupied and now 81.5% leased. Moving north to Orange County, the industrial market seems to have stabilized. You have about 3.5 million square feet of industrial space here and the industrial market vacancy rate is 6.3%. Our properties are 84.5% occupied and now 89.5% leased in Orange County.

Further north in Las Angeles, we have also made leasing progress. Shoreway Airport Center Long Beach our seven building office complex immediately adjacent to the Long Beach airport is currently 92.1% occupied and leased. Overall Class A direct vacancy here is 7.9% and total vacancy is 18.8%. In El Segundo, our stabilized properties now total 1.3 million square feet. They are 96.8% occupied and 98.1% leased. Class A direct vacancy in El Segundo is currently 12.2% and total vacancy 13.3%.

Further north in West LA, our properties total 680,000 square feet, are 78% occupied and 89.8% leased. Overall direct vacancy in the West LA currently is 14.4% and total vacancy is 19.3%. Along the 101 corridor market which runs through the northern Los Angeles and Southern Ventura County’s direct vacancy for Class A product is currently 21.4% and total vacancy is 21.9%. Our properties in the market are currently 73.9% occupied and 93.9% leased up from 80% leased last quarter, given the new 11 year lease at our Agoura Road property. We are now 94.2% leased in Los Angeles up from 91.2% last quarter.

That’s an update on our market conditions and activity. In closing we feel KRC is extremely well positioned to take advantage of opportunities in today’s challenging market place. Our acquisition activities are off to a very good start and we are making good progress with our core portfolio. Now, Tyler will cover our financial results.

Tyler H. Rose

Fourth quarter FFO was $0.57 per share. Occupancy in our stabilized portfolio was 82.8% at the end of the first quarter down from 87.6% a year ago and unchanged from year end 2009. By product type office occupancy was 81.8% and industrial occupancy was 85.3%. Overall, our properties are now 88% leased. Same store NOI in the first quarter was down 6.4% on a GAAP basis and 5.3% on a cash basis. The decline is largely a result of lower average occupancy.

For leases that commenced in the first quarter, office rents decreased 7.3% on a GAAP basis and 19.2% on a cash basis while industrial rents were up 20.2% on a GAAP basis and 23.7% on a cash basis. For leases we signed year-to-date, 95% of them were office transactions and the rents on these leases decreased 4.2% on a GAAP basis an 10.8% on a cash basis. We estimate that rent levels in our overall portfolio are approximately 5% to 10% over market.

Our current 2010 expirations total 891,000 square feet which includes the Boeing and DeVry leases. Excluding those leases our 2010 lease expirations stand at approximately 507,000 square feet.

Now, let me give you some additional funding details on our current and pending acquisitions. First, the San Diego transaction that closed in mid March totaled $18 million and was paid in cash. The second transaction covering the three additional buildings will total approximately $52 million which represents the balance on the secured note. The closing is dependent on the assumption of the note which has an interest rate of 5.1%.

The San Francisco acquisition will total approximately $237 million and will be paid in cash. As most of you know we recently sold 9.1 million shares of common stock for total net proceeds of approximately $300 million. The bulk of the proceeds will be used to fund the acquisitions we have discussed. In the meantime we’ve used the proceeds to pay down the balance on our unsecured revolving credit facility.

As a result, as of the date of this call, we have no balance outstanding on our $550 million credit line. Following the completion of both pending acquisitions we anticipate an outstanding acquisitions, we anticipate an outstanding balance of approximately $115 million on the line giving us $435 million of committed available debt capacity. We also officially extended our credit line for one year, it now matures in April 2011.

In early April, both Moody’s Investor Services and Standard & Poor’s Rating Services assigned us investment grade credit ratings. Moody’s assigned an issuer rating of BAA3 with a stable outlook and Standard & Poor’s assigned us a BBB- corporate credit rating with a stable outlook. We are currently evaluating our options regarding timing and size of a public bond offering. Having the ability to issue public debt expands the options at our disposal to access capital at competitive prices in order to fund future acquisitions or manage our existing debt maturity profile.

Finally, I want to point out that we added a new line item to the income statement this quarter which relates to acquisition related expenses. For the first quarter it totaled approximately $313,000. Now, let me finish with 2010 earnings guidance. As we have said before given today’s economy we remain cautious in our near term outlook. Our internal forecasting and guidance reflect information and market intelligence as we know it today. Significant shifts in the economy in our markets going forward could have a meaningful impact on our results in ways not currently reflected in our analysis.

Taking these caveats in to consideration, our assumptions are as follows. Last quarter we provided 2010 FFO guidance of $2.10 to $2.30 per share. We now project average occupancy for 2010 of 85% and yearend occupancy for 2010 of 87%. While we are actively pursuing additional acquisitions, given the uncertainty of timing and amounts for modeling purposes we are not forecasting any additional acquisitions during 2010.

Taking together the accretive impact of the completed and pending acquisitions and the dilutive impact of the entire $300 million of equity, the net effect is approximately $0.02 dilutive. Also, we anticipate that we could have higher 2010 acquisition related expenses than we originally forecasted of $0.01 to $0.02. Taking these assumptions together our updated 2010 FFO guidance is $2.07 to $2.22 a share.

That’s the latest news from KRC. Now, we’ll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jamie Feldman – Bank of America Merrill Lynch.

Jamie Feldman – Bank of America Merrill Lynch

In terms of pickup in leasing activity, I’d like to get a better sense of how much of it is pent up demand and just how deep or how long the runway is here for additional demand for space in people you’re talking to?

John B. Kilroy, Jr.

What we have seen is a very diverse group of customers, it’s not coming out of any one industry. If I speak to San Diego for a moment which has sort of been a trouble spot over the last couple of years with regard to leasing and now is beginning to have a little bit more sunshine, what’s happening there if you look at the absorption in 2007 net absorption for office and corporate in San Diego was roughly one million square feet, in 2008 it was -850,000 feet. In 2009 it was -952,000 square feet notwithstanding 516,000 square feet of positive absorption in the fourth quarter.

Year-to-date in San Diego, it’s been positive absorption countywide of 300,000 square feet and in the areas we tend to be net absorption office and corporate headquarters 421,000 square feet. So what we’ve seen, is a fairly broad spectrum of different types of tenants across all the markets that we are in begin to expand. It’s still a tough market with regard to rental rates and what not but what we find encouraging, if you take a look at the availability of space, Del Mar, UDC, Sorrento Mesa, Rancho Bernardo, where we have facilities, I15 corridor or Rancho Bernardo, the percentage of available space is anywhere from 75% to 90% in the 10,000 square foot category or less.

We think that is a very good sign for Kilroy because when you look at the absorption and product segmentation, it suggests the bigger companies are growing. They’re the ones that are more applicable to most of the properties we have and that market is getting cleaned up pretty nicely. Jeff, do you want to talk about Orange County and LA?

Jeffrey C. Hawken

In terms of maybe just a little more color on the lease we’ve done year-to-date, the 494,000 square feet, 31% of that is in the LA markets, 61% in San Diego and 7% in Orange County. 95% of that total leasing is in the office sector so that’s where a lot of our leasing has been distributed over our counties.

John B. Kilroy, Jr.

And with regard to how much of that is new leasing versus renewals?

Jeffrey C. Hawken

425,000 or 85% of that is new leasing versus 14% to 15% is the renewal.

Jamie Feldman – Bank of America Merrill Lynch

Then also can you give us a little bit more of your views on Northern California and now that you are about to close on an asset there kind of how big you think the opportunity set is? It sounds like San Francisco there could be a lot that trades the next couple of years. Then also, what types of assets, are you going for super Class A or is there a certain segment of the market you are going after?

John B. Kilroy, Jr.

Let me start with the asset that we’re about to close on 303 2nd Street the 730,000 square foot facility. What was appealing about that asset and it’s very consistent with Kilroy’s long belief that infrastructure is very important and if you think about it this facility is extremely infrastructure rich. It’s highly amenities as well, it’s located adjacent to the I80 freeway with a freeway on ramp right at the property, it’s two and a half blocks from the 101 freeway which gives north/south access particularly down to the peninsula, it’s near a BART station and of course it has this new transbay terminal which we really like. It just puts it in the sweet spot of the Nexis of all these different types of infrastructure elements.

What’s beautiful about that from our standpoint is it’s a multibillion dollar taxpayer funded transportation system with green belts and parks and all the transportation amenities that incredibly benefits this project. This project happens to be in the growth, it is able to take CBD tenants. You’re not going to find the ones that want to see the bay in our building because they can’t see the bay from there but is terrific for those who want to access the peninsula as well as the CBD. So that is indicative of the kind of property that Kilroy likes, amenity rich, transportation rich, the environment is going to get better and over time the asset becomes more valuable coupled with the fact that we bought it at a tremendous discount to its replacement cost.

If you think about this transportation thing, it’s a little bit like what happened years ago in midtown Manhattan where you’re near the bridge, you’re near the train station or in Chicago like Wacker Drive where the CBD expanded south and west towards Wacker because the train is going to the suburbs. We think this just gets better.

With regard to the bigger issues, the strategy in San Francisco and the type of assets, we’ve looked at just about everything that has been on the market. This is the first one that we really felt we could significantly increase in value. The 333 building that just sold with Wells Fargo is in that market. That was a Wells Fargo coupon, a long term lease, it didn’t meet our criteria. We do have a couple of other transactions we’re looking right now, one’s off market actually two are off market and they were folks who have talked to us since we bought 303.

Ultimately, we may go down in to the peninsula again. I think it’s a little too early right now, but the tech users can hockey stick up pretty quickly in demand and so we’re keeping our eye down there as well. We haven’t seen anything in the east bay that makes sense to us that we like. Although, we’ve looked at some things. So that is the philosophy towards San Francisco.

Operator

Your next question comes from Chris Caton – Morgan Stanley.

Chris Caton – Morgan Stanley

Can you also talk about investment opportunities you’re seeing percolating in San Diego? I know you recently did the deal there but if you have similar type of color for San Diego that would be appreciated?

John B. Kilroy, Jr.

Well, we have a couple of things going on. We of coursed closed on this first building and three more will follow. I think it’s again transportation, amenities, these are the things that we’ve always focused on with our office properties and this property has it in spades. Plus, it’s been under managed so it really has an opportunity for us to rebrand it, reposition it. It’s the only campus in that Mission Valley area.

As we look at other things in San Diego, we’ve been approached by a major user right now that needs new space. We really haven’t focused too much on other acquisitions in that market although there are a couple of things that are coming to us by big users. What we’re seeing there now is the early stages of folks talking to us with regard to development needs where they need campuses. Of course, you don’t build campuses unless you get the kind of return, the kind of lease term, the kinds of credit that make those sensible.

Elsewhere, just sort of the philosophy behind our acquisition program, is that we always have been known to be very disciplined about this. We buy when it makes sense and we don’t when it doesn’t. It sure didn’t for a number of years. Now, we have the opportunity to really step in on certain select quality assets and quality markets and be the recipient of other people’s misjudgment where they bought at too high a price and now those properties are getting sold at a great price per pound.

We see our acquisitions basically in two forms. One, is the fix it, there’s a problem with the building whether it needs to be rebranded or whether it needs to be leased, or whether it needs a new facelift, some kind of a value added thing. The other type asset we like is when it’s well leased and it’s extremely well located, irreplaceable building and location and can be bought with a decent going in cash flow but when a more normal market comes around it significantly increases in value just because it was bought at such a low cost per square foot and with leasing that reflects this recessionary period that we’ve gone through.

Operator

Your next question comes from John Guinee – Stifel Nicolaus & Company, Inc.

John Guinee – Stifel Nicolaus & Company, Inc.

A couple of quick questions, to get up to 87% occupied by year end given maybe the 400 basis points more of core occupancy plus dealing with the known and unknown rollovers, how many square feet of new leases do you have to sign from today on out?

John B. Kilroy, Jr.

Well the leasing as I think we said in the script, we were 88% leased today. Excluding the Boeing and DeVry leases we have 500,000 square feet of expirations and we anticipate to renew maybe a third to 40% of those leases. So that means that you have 300,000 square feet or so that is going to rollout of those expirations so you can do the math to get to what we need to do to get to the 87% occupancy.

John Guinee – Stifel Nicolaus & Company, Inc.

Then Tyler, on page 14 of your supplemental, you differentiate between non-recurring cap ex and recurring cap ex. What’s the $4 million of TIs and leasing commissions that are non-recurring? Is that first generation?

Tyler H. Rose

Yes, that would be on space where it’s the first time we’ll be spending money on the project or we’ve done a renovation of a project. It depends on the situation but where we’ve done a renovation on a property.

John Guinee – Stifel Nicolaus & Company, Inc.

Any idea which buildings that $4 million entails?

Tyler H. Rose

A lot of it is actually related to the Universal Music building in Santa Monica.

Operator

Your next question comes from Mitchell Germain – JMP Securities.

Mitchell Germain – JMP Securities

John, just curious how are you guys approaching underwriting these days in terms of rent growth?

John B. Kilroy, Jr.

We’re looking at it on a very conservative basis and it’s going to be building by building and area by area. But, I think if anything what I’m told by the folks that are the brokers selling these assets that we probably have the most conservative underwriting but it really is building by building.

Mitchell Germain – JMP Securities

Is there any near term roll in the San Francisco asset?

Jeffrey C. Hawken

If you look over the next three years on average, we have under a 5% roll in that asset.

Mitchell Germain – JMP Securities

Then my last question, Tyler, can you just walk me through the guidance once again? It seems like your occupancy forecast went up from last quarter and I got about $0.04 to $0.05 resulting from the G&A and the equity offering. Is that the way to look at it?

Tyler H. Rose

I can say our forecast on an average basis went up 50 basis points from 84.5% to 85% and the yearend occupancy went up a point from 86% to 87%. Most of the occupancy we’re talking about comes in in the fourth quarter so it doesn’t have a lot of impact on the numbers for 2010. The Mitchell lease that John mentioned commences in the fourth quarter so that again doesn’t have a lot of impact on the numbers. In terms of G&A I’m not sure what you’re referring to there.

Mitchell Germain – JMP Securities

You said about $0.01 to $0.02, is that right?

Tyler H. Rose

That’s the acquisition costs.

Mitchell Germain – JMP Securities

I meant acquisition costs.

Tyler H. Rose

With the dilution of the equity, the upside of the equity offering is at the moment we’re not assuming gets reinvested in to any other acquisition. Obviously, that could change if we do another acquisition. That lowers our numbers a little bit along with the acquisition related expenses.

Operator

Your next question comes from Michael Knott – Green Street Advisors, Inc.

Michael Knott – Green Street Advisors, Inc.

Can you clarify the yield or the cap rate on the San Diego assets? I think I heard you say cap rate of 7.5% but I understood that to be more of a stabilized yield once you get it fully leased?

Tyler H. Rose

I’ve seen some lease up but I don’t think it’s fully leased but we do have some lease up in that number.

Michael Knott – Green Street Advisors, Inc.

So the going in yield maybe has a six in front of it?

Tyler H. Rose

I think it’s high 6% yield on in place NOI.

Michael Knott – Green Street Advisors, Inc.

Then just a theoretical question for you, if you were to turnaround and market that asset say maybe a year from now assuming conditions were the same and you have it leased up, what do you think the market for stabilized asset in San Diego would be right now in terms of cap rate? Any idea?

John B. Kilroy, Jr.

I don’t mean to be cute about my answer here but I’m not really wanting to broadcast to others what we might buy something for. So, you ask us a very difficult question but if you look at some of the assets that have traded down there in a much worse market than today, they’ve traded at fairly decent cap rates and decent meaning low. I think that this particular asset you’re talking about has been an asset that no broker would bring a tenant to so our goal is not only to lease it but move the rents up and reposition it which we have a plan to do. We met on it yesterday. I’m not thinking about selling it in a year. I can’t tell you where cap rates are going to be. If I could I would be in a hedge fund I suppose.

Operator

Your next question comes from Michael Billerman – Citi.

Michael Billerman – Citi

How does the leasing pipeline look like for Mission City both in terms of leasing up of vacancy and managing the three year roll?

John B. Kilroy, Jr.

That’s a good question. I can tell you that in leasing right now in San Diego, just speaking of San Diego for a second, there’s 5.6 million square feet of active demand in the market right now. That’s down slightly from the fourth quarter because a lot of leases were consummated. In terms of Mission City, as well as every other building in which we have a vacancy in San Diego, I’m pleased to say we have tours and RFPs on every available square foot we have down there. Now, whether if those will turn in to leases remains to be seen but the market has improved dramatically with the leases that have been executed and now with positive absorption market wide for two quarters in a row, I don’t think we’ve had that for at least a couple of years.

In regards to Mission City, I do want to caution everybody, we took control of the first building which is 89,000 feet and 72% so we’re working with tenants on that. We’re also showing the other buildings but we don’t have control of the other buildings. We have to assume, which we have the right to do, pursuant to the documents the CMBS debt and those guys the servicers, take a heck of a long time so our anticipation is that we get this thing closed. We’d like to do it earlier rather than later. Our hope was to buy it for cash but that will complicate leasing a little bit in those buildings.

We have an arrangement by which we can front the money and capture the leasing but it makes a little bit more difficult. But, with regards specifically to that asset it went from being dead in leasing because of the prior owner not wanting to put up any dollars to now being very actively shown and RFPs and whatnot so I’m pretty enthused by the activity we’re seeing on that specific property.

Michael Billerman – Citi

When you underwrote the asset, the tenants that are in place that have expirations the next three years, what was your sense in terms of each of their willingness to stay or need to get smaller or bigger or renew?

Tyler H. Rose

I think we figured about 65% renewal.

Michael Billerman – Citi

Just lastly, is DeVry definitely vacating your portfolio this year?

Tyler H. Rose

Well, let’s just say that their lease expires in the third quarter. They don’t have any options, they don’t have any hold over and the building they were having built for them is not being built for them, the property has gone back to the seller and they have requested a lease proposal. We’ve gotten a counter proposal and we have a negotiation going on so more to come.

Michael Billerman – Citi

But your guidance assumes that they vacate?

Tyler H. Rose

That is correct.

Michael Billerman – Citi

If you think about an unsecured bond issuance after getting the ratings, I assume a minimum debut size has got to be $250 million plus. How are you weighing raising that capital? I guess being a use of proceeds you could maybe tender for more of the converts or buy out the preferreds, pay down the line a little bit more though post equity offering I don’t think you have much there. How are you thinking about when to use that, what the cost of that is, how does that fit in your cap structure relative to having converts and things like that outstanding.

Tyler H. Rose

Well you’re right we wouldn’t do anything smaller than $250 million and if you did for example $250 or $300 million deal clearly the primary use of proceeds would be to tender for some of our convertibles. We also have a $61 million private placement that comes up in august that I think is at 5.7% and then as you pointed out we could pay down our line a little bit although that’s more dilutive. If we buy back our convertible or pay off that $61 million unsecured private placement on where we could raise money right now sort of on a five year basis it’s below 5%, on a 10 year basis it’s mid 6%.

It’s sort of flat to slightly dilutive but not materially dilutive to pay down the convertible or private placement. So we’re thinking about all those things and evaluating the timing but more to come on that.

Michael Billerman – Citi

I realize there’s not any guidance but is that something you believe is near term to happening or you would wait for more acquisitions to happen? What needs to line up?

Tyler H. Rose

We don’t need to have necessarily acquisitions because as I said the use of proceeds could just be paying down debt which again its sort of flat but it extends our maturity so it would be more a debt maturity strategy than a funding for acquisition strategy.

Michael Billerman – Citi

What does the balance sheet look like just post equity deal, post all the acquisitions, what’s cash balance, what’s line of credit balance?

Tyler H. Rose

Well we said that our line of credit once we finish with the acquisitions we’ll be $115 million outstanding on the line so we’ll still have about $435 million of capacity and we have about $880 million I think of debt right now so that brings it back to about $1 billion. Our current fixed market cap is about 29% so that would bring it in to the low 30s and we could clearly have some room to run obviously having done the equity offering to not have to raise equity, depending on the size of the next acquisition, but we have a lot of funding capacity at the moment.

Michael Billerman – Citi

Your thought process of coming out with the equity offering at about $250 million and lifting it to $300, your mindset was take it when you can get it or we have other things that are in the hopper, it would be good just to take more the equity today rather than having to come back?

Tyler H. Rose

More the latter than the former.

Michael Billerman – Citi

What’s in the hopper today? I don’t know, do you have stuff under letter of intent? Have you gone under contract in anything? Just give us a sense of how near term other deals may be?

John B. Kilroy, Jr.

Without getting too specific, we do have a number of proposals that are on the table that are being evaluated by the sellers and again, we’re sort of in three of those right now and they’re all fairly substantial. Not as big as San Francisco but fairly substantial.

Michael Billerman – Citi

What would the size of the bread box be?

John B. Kilroy, Jr.

Let’s just say it could be $200 to $350 million.

Michael Billerman – Citi

A piece or totality?

John B. Kilroy, Jr.

Aggregate.

Operator

Your next question comes from Dave Rodgers – RBC Capital Markets.

Dave Rodgers – RBC Capital Markets

I just wanted to follow up on the guidance question as well, do you have any capital initiatives in your plan for the second half of the year?

Tyler H. Rose

We don’t have any acquisitions or dispositions in the model.

Dave Rodgers – RBC Capital Markets

What about working the capital along the lines of an unsecured issuance or some of the refinancing of the debt, is that what drove some of maybe the difference in your guidance?

Tyler H. Rose

We don’t have an offering in the guidance now although as I said I don’t think an offering assuming we pay down debt has much impact on numbers on the guidance. So no, we don’t have any financing assumptions in the model that would impact guidance dramatically.

Dave Rodgers – RBC Capital Markets

Just to go back to the other question, you brought guidance down quite a bit and you highlighted about $0.04 or so of the rational to do that. It seems like excluding Boeing and DeVry you need probably only about 250,000 to 400,000 square feet of leasing excluding the renewals given your rates to really hit your leasing target by the end of the year so it would seem that you’re fairly conservative on your outlook for the year yet you turned the guidance down so I guess I’m wondering what the differential between the two would be? Is it spreads coming in lower because it doesn’t seem to be that and maybe I’m just missing something in the math walking through.

Tyler H. Rose

The guidance came down $0.02 or $0.03 on the low end and we tightened the reins on the high end on the $0.08. Our midpoint previously was in the $2.18 to $2.19 range and we’re now at the $2.14 range so we’re only down $0.04 on guidance which is about what I explained in terms of the equity offering and the acquisition related costs. We did tighten the reins more on the high end but from a midpoint perspective we’re down about $0.04 from where our midpoint was.

Dave Rodgers – RBC Capital Markets

John, I think last quarter and I didn’t hear you mention it on this call, maybe you could, you talked last quarter about letters of intent that you had, at this point of the year do you have any additional on top of the leasing that you’ve already announced?

John B. Kilroy, Jr.

We do. We have 160,000 square feet of LOIs in two or three different transactions right now that we’re feeling good about. But, you never feel totally good until you’re converting the leases but that was an oversight on our part not to mention that.

Dave Rodgers – RBC Capital Markets

Final question, in the second quarter what are the blend of leasing spreads we should be looking for in the office portfolio given that they were down further on our 4Q signings and not as bad year-to-date?

Tyler H. Rose

You’re asking what we expect our change in rents will be in the second quarter?

Dave Rodgers – RBC Capital Markets

Yes.

Tyler H. Rose

I think what we signed in the first quarter was down less than what commenced in the first quarter. So if that trend continues the change in rent should be better in the second quarter and for the remainder of the year. But, we hate to forecast that number, it just depends what commences and so forth. But, we’re anticipating a little bit of an improvement in that number.

Operator

Your next question comes from Ross Nassbaum – UBS.

Ross Nassbaum – UBS

I don’t know if this was touched on before but do you have any thoughts on Prop 13 at this point? Is there any probability whatsoever at this point that a reappeal is on the table or does that seem to have gone by the way side?

John B. Kilroy, Jr.

Well, as all of you know from NAREIT I’m not the greatest advocate of the government so I won’t get in to my speech about what all these nincompoops can do on any given day but the primary supporters as I understand it, we defeated, we were active in that. My understanding now is it dead and the primary sponsors of it which is some of the unions, have agreed that they don’t have a chance.

You never know in the future when people might bring up this idea or some other crazy idea so it’s important for the industry to be vigilant and that is what Kilroy is extremely vigilant on these issues but right now it’s dead.

Ross Nassbaum – UBS

As a Citizen of California how do you think the state faces the budget problem without some drastic measures on the tax side of the equation whether it’s for individuals or businesses?

John B. Kilroy, Jr.

Well, you know we could get in to a real long discussion on that. They don’t have the printing press fortunately. California, like everyone else always has their hand out to the current Washington administration. That ultimately I hope has to dry up and what they’ve got to return to is fiscal discipline. I can tell you the mood of Californians is probably as intense if not more intense than the national mood which is government is no longer your friend. It’s too big, they’ve got to tackle the unfunded pension funds and so forth that like everywhere else in the country are a problem.

Even though I am not a proponent of big government and there are a lot of things that I don’t like in California as well as other areas, I am actually kind of encouraged for the first time in a long time because it’s sort of like the individual that kept getting a new credit card in the mail and now they’re not getting anymore and they’ve got to work their way out.

There is going to be some pain for sure but I think when I speak to other business people and leaders that are involved with working in government to make it more responsible on both sides of the aisle there’s actually a degree of optimism right now. I guess the key words would be we’ve got a problem, it’s going to have to be worked out. I think people are now talking about the very difficult issues. Both sides of the aisle are and even the unions are and that gives me some optimism.

Ross Nassbaum – UBS

If I look at your assets in Serrano Mesa and the I15 corridor, can you remind me of the assets in those markets that are showing 0% occupancy, how many of them are currently configured as single user buildings versus those that are already set up for multitenant?

John B. Kilroy, Jr.

Well most of the buildings, even the two story corporate headquarters we do, we design them such that they can be broken up. They can’t always been broken up in to small little 5,000 and 10,000 foot elements but that’s not what’s driving those markets.

Ross Nassbaum – UBS

I’m just asking generally.

John B. Kilroy, Jr.

If you look at I15, our Class A product is essentially all leased. We have 78,000 foot building for which we have a 50,000 square foot letter of intent which was previously HL, one of the other buildings next door. We have a 15,000 or 20,000 feet and we have people actively looking at those. Then over at Sabre Springs Corporate Center, we have a 60,000 foot building with 20,000 left and a 40,000 foot that’s been painful for us because we bought it and then the market went to hell. But, we have a number of users that are looking at that building and we’re going through space planning and so forth.

If you drop to Serrano Mesa, we have the building the TeleTech that Nugent Results was in that we have a big lawsuit because they decided not to honor their lease and walked away. It’s a three story building, it’s roughly 100,000 feet. We have some groups that are looking at single floors and some that are looking at all the floors and those floors can be broken up although our plan has been to try and get a bigger deal.

If you move to Serrano Gateway where we had the 50,000 building we constructed and go caught in right in ’07 and ’08, I guess ’08 it came on stream, we’ve leased half of that building, it’s roughly 60,000 feet, we leased have of that to Samsung at the beginning of this quarter or the last quarter. They just expanded in to another 18,000 feet so we’ve got a small piece left there.

We’ve got the MOB which is roughly 55,000 feet and we’ve leased 25% of it. We’re dealing with tons of doctors but it’s very painful dealing with that crowd. Then also in Serrano Mesa, we have the buildings that came back from Epicore that were roughly 175,000 feet. We have two or three different groups that are interested in those buildings one of which would want to expand in to the adjacent lot where we could build 50,000 to 100,000 feet.

I’m missing something, we have a couple of other little buildings up further up, Pacific Center Court which is 80,000 feet and we’ve got somebody that’s interested in 50,000 there. I think we’re going to do just fine. They do break up but they don’t break up in to 2,000 square foot increments.

Operator

Your next question comes from Mitchell Germain – JMP Securities.

Mitchell Germain – JMP Securities

Just remind me the size of the DeVry lease?

John B. Kilroy, Jr.

The DeVry lease is just under 100,000 square feet. It’s two floors and they’ve initiated a proposal to us to lease one floor longer term and we’re deciding whether we want to try to make them lease more or lease less or just what we’re going to do. We really can’t talk too much more because it’s an active negotiation and you never know who’s going to listen to the call.

Operator

We have no more questions in queue and this concludes our Q&A at this time.

Tyler H. Rose

Thank you for joining us today. We appreciate your interest in KRC.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. This concludes our presentation. You may now disconnect.

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